Robinhood (NASDAQ:) has revolutionized trading markets with its easy-to-use, free platform. Shares in the zero-fee trading platform follow a well-known trajectory. Like recent rallies in meme stocks, it has become the center of attention for retail investors.
Robinhood shares rose 50% on Wednesday after an army of individual investors joined Cathie Wood, who bought shares in the trading platform following its IPO last week. The frenzied share purchases pushed the company's market value to a peak of $65 billion from $29.1 billion after its July 28 debut. Yesterday, Robinhood closed at $50.97, down nearly 19.5% on the day.
The California-based company attracted private investors after giving about 25% of its IPO shares to its own clients. HOOD was a "top traded stock" on Fidelity, which is generally a good indicator of individual investor interest on any given day.
The moves of this magnitude placed Robinhood in the group of highly volatile meme stocks, such as GameStop (NYSE:) and AMC Entertainment (NYSE:). But the question for long-term investors is quite simple: is it the right time to buy Robinhood?
According to Atlantic Equities, which has a price target of $65 per share on the stock, Robinhood is on a solid growth path that makes its stock attractive to growth investors.
In a note from last week, the brokerage said:
"We believe this superior user growth will continue given the success of the referral program and the product's appeal to the target audience."
In addition to the potential for user growth, Robinhood also has an advantage in how much revenue it generates per user, Atlantic said, adding:
"While Robinhood has achieved three-year sales of 169%, we see potential for the company to further expand its product portfolio."
ARK Invest chief Cathie Wood, who is popular on internet forums such as Reddit's WallStreetBets, bought more than 89,600 shares of Robinhood on Tuesday for its ARK Fintech Innovation ETF (NYSE:). That purchase comes on top of Wood's previous purchases of 3.15 million Robinhood shares since last week's IPO. Despite this enthusiasm, there are some clear risks to Robinhood's earnings model that long-term investors should consider when investing in this name.
Robinhood is on a collision course with regulators over a controversial practice that generates most of its revenue. Robinhood revealed that 81% of its first quarter revenue came from sending its customers' orders on stocks, options and cryptocurrencies to fast trading firms – a practice known as order flow payment.
Securities and Exchange Commission chairman Gary Gensler said in June that the SEC was reviewing payment for the order flow, fueling speculation that the practice could be banned.
In a June CNBC interview, Gensler questioned the brokerage's argument that pay-for-order-flow arrangements have allowed retail investors to trade stocks for free.
“I think that's a misconception. It's not free trade," Gensler said. “It's not a commission, but not necessarily free,” he added, noting that the profits from the data brokers are valuable.
These uncertainties and large private investor participation may be behind the large sell orders from Robinhood's early investors. In a filing announced Thursday, the company revealed that more than a dozen of its existing shareholders had applied to sell up to 97.9 million shares in a post-IPO stock offering. These investors include many of the company's largest investors, including New Enterprise Associates, Ribbit Capital, Thrive Capital and Andreessen Horowitz.
Bottom Line
Robinhood is a new addition to the group of meme stocks that we do not recommend to long-term investors due to their detachment from the fundamentals. That said, Robinhood has a solid business that could see further growth if the SEC review doesn't hurt its existing business model. As long as that uncertainty continues, it is better to stay on the sidelines.
